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Expansion Projects to Drive Southern Copper, Debt Rises

On Jan 21, we issued an updated research report on Southern Copper Corporation SCCO. The company continues to witness the benefits of cost-reduction programs and expansion actions. Backed by its constant commitment to increasing low-cost production and growth investments, Southern Copper is well positioned to continue delivering enhanced performance. However, high debt and lower copper production for fiscal 2018 at its Buenavista SX-EW plant remain concerns.

Expansion Projects to Drive Growth

In 2019, the company anticipates reaching full capacity at its new Toquepala concentrator and recover production at the San Martin mine. In order to restart operations at the San Martin mine, the company has undertaken a major renovation initiative with an estimated capital budget of $77 million. Once in operation, it will have an annual production capacity of 20,000 tons of zinc, 2.8 million ounces of silver, 8,000 tons of copper and 1,000 tons of lead. Consequently, the company anticipates an increase of 13% in production of copper, 38% in zinc, 31% in silver and 21% in molybdenum in 2019 compared with the 2017 levels. At the average prices of the third quarter, these production enhancements would represent sales accretion of more than $800 million.

In Mexico, the company has a planned investment of $413 million in the Buenavista Zinc-Sonora project which includes the development of a new concentrator to produce approximately 80,000 tons of zinc and 20,000 tons of additional copper annually. Once completed, this new zinc concentrator is likely to double the company's zinc production capacity.

An investment of $159 million is estimated for Pilares-Sonora project in Mexico which consists of an open pit mine operation with an annual production capacity of 35,000 tons of copper in concentrates. It will significantly improve the overall mineral ore grade. In Peru, a new-state-of-the-art concentrator for $1.3 billion at the Toquepala project will increase annual production by 100,000 tons to reach 258,000 tons in 2019, reflecting an increase of 74%. In addition to these, the company has number of other projects that it may develop in the future. Notably, the company expects to reach 1.5 million tons of copper production by 2025.

Peru: A Key Catalyst

In June 2018, Southern Copper completed the acquisition of Michiquillay project in Cajamarca, Peru, which boasts mineral resources of 1,150 million tons and a copper grade of 0.63%. It will produce 225,000 tons of copper annually and by-products such as molybdenum, gold and silver, at a very competitive cash-cost. Michiquillay offers immense growth opportunities for the company and fits into its portfolio of mining projects in the Americas, especially in Peru. It is likely to become one of the largest copper mines in Peru.

The new administration in Peru is expected to provide stability, economic growth and social progress along with a favorable environment for the company to develop its projects of Tia Maria, Los Chancas and Michiquillay, with a combined investment of $6.7 billion. Once operational, these projects will increase the Peruvian copper production by about 500,000 tons. Peru is currently the second largest producer of copper and its national output is expected to hit 4.8 million ton per year by 2021 — double the output of 2017.

Increase in Long-Term Metal Prices to Boost Revenues

Copper production has recently been affected by persistent decline in investments. Notably, this issue has been plaguing several companies in recent years. On top of this, labor unrest, excess government taxation and technical difficulties are impacting production further. All these factors will restrict supply growth while demand is on the rise for the metal given its demand across a gamut of industries. This demand-supply imbalance will eventually drive copper prices.

Molybdenum prices are set to increase on the back of healthy demand from the oil and gas industry, and decline in supply growth. Long-term fundamentals for zinc remain strong due to its significant industrial consumption and expected mine production shutdowns. Further, silver prices are likely to gain driven by its industrial use and impending demand-supply imbalance.

Lower production at Buenavista SX-EW plant to Impact Results

In the first nine-month period of 2018, copper production decreased 0.3% year over year dragged down by a lower production at the Buenavista SX-EW plant. This can be attributed to the lower solubility index in the new leach pads and the characteristics of the ore that is being deposited in such pads. The company has developed a 12-month corrective program to overcome this temporary reduction in production. Though the company expects a sequential increase of 18% in copper production for the facility in the to-be-reported fourth quarter, it has led to lower production for the full year. The company has cut down copper production guidance for fiscal 2018 to 885,000 tons from the prior 901,000 tons.

Further, copper prices have been subdued due to the trade tussle between the United States and China. This is likely to weigh on Southern Copper’s near-term results.

Further, the company's debt-to-equity ratio is currently at 90%, which is a cause of concern.

Shares of Southern Copper have dipped 35.5% in the last year, compared with the industry’s decline of 37.8%.

Southern Copper currently carries a Zacks Rank #3 (Hold).

A few better-ranked stocks in the basic materials space are Ingevity Corporation NGVT, Cameco Corporation CCJ and Israel Chemicals Ltd. ICL. All the three stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Ingevity has an expected earnings growth rate of 21.5% for 2019. The company’s shares have gained 22% in the past year.

Cameco has an expected earnings growth rate of 20% for 2019. Its shares have rallied 23% in a year’s time.

Israel Chemicals has an expected earnings growth rate of 5.4% for 2019. Its shares have rallied 33% in a year’s time.

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